Lessons from over the ditch

Here’s a useful lesson for Australia as it struggles with reform fatigue and the collapse of its productivity growth.

New Zealand, which led Australia and the world through the era of economic reform, is grappling with the same problems in a more acute form.

The Organisation for Economic Co-operation and Development has just published its latest report on the New Zealand economy, including a detailed review of the factors that have left New Zealand’s per capita income 50 per cent below that of the United States and 30 per cent below that of Australia.

Part of the problem, according to the OECD, is reform fatigue.

New Zealand has to work even harder than Australia to overcome the combined disabilities of isolation and smallness – but, like Australia, it has been resting on its oars.

“In more recent years, the intensity of New Zealand’s reform effort has fallen and . . . some policy changes have made the regulatory environment slightly less conducive to competition," the report says.

“This may reflect a surprisingly prolonged period of ‘reform fatigue’ after the sometimes tumultuous reforms of the late 1980s and early 1990s and a view that those reforms should have been sufficient to move New Zealand’s regulatory structure to some ideal state."

The OECD uses indices of product market regulation to compare the restrictiveness of countries’ regulatory regimes. They show that product market reform has lost momentum in New Zealand while most other OECD countries have continued improving their regulatory environments.

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“New Zealand is no longer at the forefront of regulatory policymaking but is about average in the OECD," the organisation says.

That looks like a costly mistake. The combination of small domestic markets and high international transport costs means the potential to exploit economies of scale and specialise is limited. This lack of scale is thought to be restraining productivity growth.

The OECD’s answer starts with a small country’s version of competition policy. Small markets usually can support only a small number of big businesses. The trade-off for small countries that want the benefits of modern technology is a small number of competitors.

Australia suffers the same disability: two large grocery retailers, two large airlines, four major banks and so on.

However, if markets must be concentrated, they might at least be made more contestable. That is, the government can make sure there are no artificial barriers to the entry of new competitors so that the incumbents cannot take their dominance entirely for granted.

“If the threat of competition is credible, incumbent firms will perceive that pricing above competitive levels will attract entry and therefore refrain from anti-competitive behaviour and work to improve productivity so as to minimise costs and enhance profitability," the OECD says.

“The number of competitors is only one determinant of market performance, and the regulatory environment needs to ensure that other determinants – such as barriers to entry – are highly supportive of productivity growth. In addition, with large companies dependent on exports the regulatory framework also needs to emphasise the minimisation of barriers to international trade and investment."

These are issues in Australia too. For example, the Productivity Commission has found that regulation of urban land by local government – which routinely blocks new businesses to protect the viability of incumbents – is a barrier to the entry of new competitors in grocery retailing.

It may be true that our market is too small to attract a full-scale assault by Costco and Aldi. But the possibility of new entrants, and the greater opportunity for Coles and Woolworths to contest each others’ monopolies – might inject new competition into grocery retailing.

New Zealand’s problems with the regulation of natural monopolies also contain lessons for Australia. The Kiwis were world leaders in reforming the so-called network sectors (electricity, gas, water, transport and communications). Their reforms focused on separating the potentially competitive parts of the businesses from the natural monopolies: the wires, pipelines and the rail lines.

Access by competitors to the natural-monopoly facilities was then subject to a “light-handed" regulatory framework that consisted of the basic competition law and the threat of government intervention and price controls in the event of anti-competitive behaviour. However, the effectiveness of light-handed regulation in providing access to new entrants increasingly has been questioned.

The result was a large swing in the pendulum, with re-regulation and the re-acquisition by the government of interests in the rail and airline networks.

On the OECD’s assessment, New Zealand’s regulation of the network industries has become “significantly less conducive to competition than those of Australia and the United Kingdom".

But Australian federal and state politicians are grappling with the same basic problems, albeit in slightly different forms – in transport, telecommunications, energy, water supply – where the choice is between public and private ownership, or between degrees of intervention and regulation.

There are no easy, sure-fire solutions, but we can again learn from the Kiwis and avoid their worst mistakes.